The Complex 'Interest Rate Calculation' of the Bank of Korea... Rising Calls for a Hike After Freeze

Market Confusion Over US Indicators
Concerns Ahead of June 23 Financial Policy Meeting

[Asia Economy Reporter Seo So-jeong] As U.S. employment, inflation, and consumption indicators simultaneously point to a 'tightening' clock, the Bank of Korea's calculations for setting this month's base interest rate have become more complicated. With growing weight on the possibility that the U.S. Federal Reserve (Fed) will maintain interest rates at a higher level and for a longer period than expected, the market, which had already assumed a 'freeze,' is now rapidly embracing the case for a rate hike.

According to the Bank of Korea on the 16th, ahead of the Monetary Policy Committee meeting scheduled for the 23rd, the shock from U.S. economic indicators is deepening the Bank's dilemma. With just a week left before the base rate decision, all major U.S. economic indicators have exceeded market expectations, making it impossible to completely rule out the possibility of a rate increase.

With consecutive releases of unemployment rate, Consumer Price Index (CPI), and retail sales data raising the likelihood of additional rate hikes, the gap between the Fed and the market, which had shown differing views on inflation, is rapidly narrowing. A Monetary Policy Committee member cautiously stated the day before, "Looking at the U.S. indicators, it would not be surprising if the base rate goes up to 3.75%," adding, "Considering the rapidly changing U.S. market sentiment recently, it would not be awkward for the Bank of Korea to raise rates once more."

The urgency for a rate hike has surged because the early end to U.S. tightening has rapidly lost momentum, and Fed officials continue to suggest that the terminal rate could rise as high as 5.5%. John Williams, President of the New York Federal Reserve and the third-ranking official in the Fed, evaluated on the 14th (local time) that "a range of 5.0 to 5.5% for the year-end base rate seems to be the appropriate framework."

Regarding this, a Monetary Policy Committee member previously mentioned, "I expected the U.S. terminal rate to rise by 0.5 percentage points, but if it goes up by 0.75 percentage points to 5.50%, it would be difficult for the Bank of Korea to keep rates frozen at 3.5%." In this case, the interest rate gap between Korea and the U.S. would widen to 2.0 percentage points, which is unprecedented considering the historical maximum gap was 1.5 percentage points. This could lead to renewed volatility in the exchange rate, which has recently shown a relatively downward stabilization trend.

Jo Young-moo, a research fellow at LG Economic Research Institute, said, "I expect the Bank of Korea to raise the base rate by 0.25 percentage points at this Monetary Policy Committee meeting," adding, "This is because inflation remains uncontrolled and global monetary tightening continues." Jo also stated, "I believe the acceptable interest rate gap between Korea and the U.S. is up to 1.5 percentage points," but added, "Even if the policy rate inversion between Korea and the U.S. expands beyond 1 percentage point, the risk of large-scale capital outflows or crises is low."

On the other hand, Lim Jae-kyun, senior research fellow at KB Securities, said, "The February Monetary Policy Committee will keep the base rate unchanged," noting, "According to the minutes of the January meeting, some members who judged the terminal base rate to be 3.75% were also passive about further hikes." While the possibility of additional hikes exists if the Korea-U.S. base rate inversion widens and the won becomes unstable, the freeze remains the more likely scenario.

In particular, the replacement of Monetary Policy Committee members is emerging as a new variable as Joo Sang-young and Park Ki-young complete their terms in April this year. Both Joo, recommended by the Financial Services Commission, and Park, recommended by the Bank of Korea, have terms ending on April 20. Joo Won, director of Hyundai Research Institute, forecasted, "Ahead of next year's general election, political demands for rate cuts may intensify in the second half of the year, so there may be opinions within the Monetary Policy Committee to raise rates in the first half if possible," adding, "The inclinations of the Monetary Policy Committee members appointed by the Yoon Suk-yeol administration will also be a significant variable for the future interest rate path."

This content was produced with the assistance of AI translation services.